RWP 22-07, July 2022
Recessions often have detrimental effects on both employment and equity prices, forcing individuals to make decisions about how to balance risks to their labor and capital income. In this paper, we study how individuals allocate their limited attention between capital income and labor income risks in a two-period consumption-saving model with recursive utility. Specifically, we examine how the optimal attention and consumption-saving decisions are influenced by individuals' attention capacity, wealth endowments, preferences for risk and time, and income risks. We show that our model is consistent with several novel facts regarding how differences in individuals' wealth levels and beliefs about their unemployment risks influenced their consumption during the Great Recession. Furthermore, we find that the welfare loss due to limited attention is significantly larger for households with lower wealth; allowing these households to flexibly allocate their attention can significantly reduce this welfare loss.
JEL classifications: C61, D83, E21
Yulei Luo, Jun Nie, and Penghui Yin. 2022. “Attention Allocation and Heterogenous Consumption Responses.” Federal Reserve Bank of Kansas City, Research Working Paper no. 22-07, July. Available at External Linkhttps://doi.org/10.18651/RWP2022-07